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SUBPRIME LENDING 

Residential Mortgage-Backed Securities

Financial institutions packaged subprime, Alt-A and other mortgages into securities. As long
as the housing market continued to boom, these securities would perform. But when the
economy faltered and the mortgages defaulted, lower-rated tranches were left worthless.

1 Originate RMBS
Lenders extend mortgages, including TRANCHES
subprime and Alt-A loans. Low risk, low yield

Pool of
Mortgages
2 Pool
Securities firms AAA SENIOR
TRANCHES
purchase these loans
and pool them.
First claim to cash flow
from principal & interest
payments…

3 Tranche
Residential mortgage-backed
securities are sold to
investors, giving them the
next
right to the principal and claim…
interest from the mortgages.
These securities are sold in
MEZZANINE
tranches, or slices. The flow TRANCHES
of cash determines the rating These tranches
AA
of the securities, with AAA were often
next… purchased by
tranches getting the first cut
etc. CDOs. See page
of principal and interest 128 for an
payments, then AA, then A, explanation.
and so on. A
BBB
BB
EQUITY TRANCHES Collateralized
High risk, high yield Debt
Obligation

Figure .